Monday, June 6, 2016

Flattening of the yield curve

I am not sure the current flattening yield curve predicts anything because the yield on the 10 year Treasury is low and declining.

From my observations, a recession follows a flat or inverted yield curve (10 year note minus the 2 year) when the long term interest rates are climbing, or have been climbing, and the short term interests rates rise to meet them.

In the past, long term rates have been rising because of a heated economy.  Then the Fed increases short term rates in an attempt to cool down the economy which cooling down turns into a freeze so to speak, a recession.

Presently, long term rates are not rising and the economy is not hot.  So long term rates are low and the recent increase is short term rates is bringing the two rates closer together.

But because the long term rates have not been climbing nor are they high, I don’t have any idea what this means when the short term rates are climbing.

I do have to note that while the long term rates are not high historically speaking, they maybe be high in the sense that rates in general have been declining over decades and long term rates may be low in a sense of it being normal now.

Perhaps then, long term rates don’t need to be high or climbing very much for a recession to be predicted once short term rates start to converge on long term rates.  Because this could be true I will continue to keep an eye on the 10-2 spread.

With jobs appearing to slow down, and a shallow industrial recession, it doesn't seem good for the yield curve to be flattening, even if because of low long term yields the whole yield curve seems muted.

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